Critical Path: Building infrastructure on the Net

CBS.MarketWatch.com

SAN FRANCISCO (CBS.MW) -- Infrastructure is the place to be on the Net, and while many investors have already taken note of leading players, there are still companies out there that are undervalued. Well, for some investors, anyway.

Perhaps Critical Path
cpth
may be worth revisiting. The stock hasn't been overlooked, really. After an 80 percent nosedive from a high-water mark of 119 on March 19 left shares resting gingerly on top of the company's IPO price of $24, investors began placing their bets. Shares have since retraced about 25 percent of the decline from peak to trough. Shares traded at 45 in recent activity.

Still, at current levels, Critical Path trades at about 14 times 2001 sales, according to Jack Ripsteen, an analyst at Chase H&Q, the investment bank that helped take Critical Path public and secure a second round of public financing just two months later.

The price-to-sales multiple is well below the top-tier cluster of Net infrastructure plays, such as InfoSpace
INSP, +5.71%
and Inktomi
inkt
which trade at around 52 times, according to Ripsteen.

Some analysts argue that torrid growth, a big market opportunity, the outsourcing of e-mails, and profitability around the corner, should warrant a greater multiple.

The company is expected to generate sales of $132 million this year, up 725 percent from a year ago. And it's expected to turn a profit by the fourth quarter of 2000. That's not bad for a company that went public back in March of last year with about $1 million in sales for the first quarter.

Well, there's nothing like using public money to go into the market and start buying revenue.

Two months after Critical Path's IPO, the company went back to the public markets to raise $173 million, in a follow-on offering. It was the fastest turn-around from IPO to secondary since the beginning of1998, according to CommScan L.L.C.

And the company has been pretty busy, making over half a dozen acquisitions, and recently completing a convertible debt offering.

"They've been executing an intelligent, hyper-growth strategy," said Ripsteen.

That's perhaps one reason, however, the stock has been under pressure. "They were put in a penalty box from making all these acquisitions," said Kris Tuttle, an analyst at Wit SoundView, who believes Critical Path has been in the box too long.

Chase H&Q's Ripsteen believes that emphatically, having upped his rating to a "strong buy" this past Tuesday, matching the consensus estimate of the other 10 analysts that follow the company, as tracked by First Call.

"The company has similar business objectives, in terms of long-term gross margins of 70 percent, operating margins of 30 percent, market opportunities and path-to-profitability goals as the other leading infrastructure plays," said Ripsteen. Yet, Critical Path has been a laggard.

However, company checks, the perfunctory pre-earnings check-ups conducted by analysts, conclude that business is on track and the outsourcing trend is still ramping up.

"We've been too conservative, and we get a sense that there's a lot of new customer contracts in the works," he said, after making his rounds. Moreover, customers are adding additional services, such as calendaring and applications."

"There's a lot of upside with this stock," said Tuttle. That said, expect about 3.3 million in shares coming off a lock-up in mid-June as a result of recent acquisitions to put potential pressure on the stock. But, according to Ripsteen, it's an opportunity to buy.

Evolution of a search engine

As some have heard me say before, at its core, Inktomi
inkt
is all about scalable, robust infrastructure. It's technology that can power the most robust processes. To that end, Inktomi has won over many investors.

Skeptics or those who lean on the conservative side, such as Tuttle, would argue that Inktomi's price is a bit "ahead of itself."

Inktomi, sporting a market valuation of some $14 billion, is worth about $12 billion, he estimated. That's based on his DCF (discounted cash flow)-with-a-twist methodology. Oh, come on -- what's a couple of billion among friends? Okay. Seventeen percent is a meaningful drop.

Tuttle projects Inktomi's market cap. Then he determines how much revenue Inktomi will generate in that year, as well as how much will fall to the bottom line. He takes that future number and discounts it back to the present value. Those estimates are based on Inktomi's current client base and market opportunities.

Those forecasts are likely to change if Inktomi stays on the fast-track.

On Thursday, Inktomi made a move to tap into the growing corporate intranet market. It's spending $344 million to buy Ultraseek, a unit of Disney's Go.com
GO, -3.12%

"We bought 30 people and over 1,500 customers," with estimated sales of $20 million for the year, said Inktomi President Dick Pierce, in an interview with CBS.MarketWatch.com.

"They're picking off the low-hanging fruit," said Chase H&Q's Ripsteen, referring to the search business.

And that low-hanging fruit is hanging lower every day. In a recent interview with Alta Vista Chief Executive Rod Schrock, the enterprise market is one segment of search he's targeting. Inktomi, after all, has won the portal market, he conceded.

Reasons for the deal

There appear to be two reasons for the Ultraseek deal. Ultraseek has developed a software package that a corporation can purchase and install themselves. Through this product, Inktomi will now offer a "dedicated search cluster," or a customized search solution for a corporation. That would include a corporation's existing database, dedicated portions of the Web, as well as Web searches, Pierce explained.

Move over Verity
VRTY, +0.23%
and Autonomy
AUTN, +0.39%
the incumbents of this corporate intranet search business, Inktomi appears to be hungry for a piece of that corporate pie.

Beyond search, Pierce tells me that investors can expect Inktomi to begin generating sales from its wireless efforts. The company plans to make client announcements, either wireless carriers or portals, that will deploy location-based services. Inktomi will generate sales on a pay-as-you-serve basis. That is, as mobile users access information about driving directions or hotels. Inktomi receives a piece of that service.

And what's a Net business without B2B exposure? Not to throw around the once-gushy rhetoric, the strategy does make sense.

As more online exchanges are created, there will be a greater need for searching products or other infrastructure services within those e-marketplaces.

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